Address the root causes of food inflation

Soaring retail prices of onion and potato have hogged headlines once again. In fact, in May, retail rates of essential commodities had risen significantly. Prices of fruit grew by 23.17 per cent, along with all vegetables (15.27 per cent), milk products (11.28 per cent ) and eggs, meat and fish (10.11 per cent). However, in June overall food inflation fell to 7.9 per cent. But that’s hardly a solace; with 90 per cent of India all set to have deficient monsoon, the threat of food shortage is alive and kicking.

India is the top producer of milk, pulses, livestock, fisheries and poultry, and the second largest producer of fruit, vegetables, rice, wheat and sugarcane. Yet, rising food prices pose the toughest macroeconomic challenge to the country. Is it just a case of seasonal demand-supply mismatch or a larger issue of gross mismanagement by governments? Can cracking down on hoarders and banning future trading tame it?

A series of market-distorting policies on production, procurement, distribution and trade in farm commodities are strangulating the supply side, leading to its falling short of demand. This, in turn, fuels food inflation. And the problem has been made worse by rapid urbanisation and growing preference for non-cereal food aided by rising incomes.

Take the Essential Commodities Act (ECA). This legislation empowers the Government to declare any commodity as essential and impose stocking limits, which creates uncertainty in the market.

There’s another problem. The Agricultural Produce Market Committee (APMC) Act mandates the purchase and sale of agricultural commodities in government-regulated mandi s. The journey of a commodity from farm to fork involves multiple levels of transportation and handling expenses, agents’ commission and mandi taxes — all jacking up the final price of the farm produce by up to 20 per cent.

Also, anywhere between 5 per cent to 40 per cent of food is wasted depending upon the perishability of the item. Thus, the farmer’s farm gate price is suppressed while retail price is inflated. The major chunk of this difference is appropriated by intermediaries, leading to low net realisation to farmers and demand for hikes in support prices. Besides, coverage of select farm commodities under the minimum support price (MSP) weakens the effectiveness of price signals in ensuring optimal resource allocation.

Higher MSPs are needed to compensate for the rising cost of farming, but arbitrarily raising MSPs of cereals vis-à-vis non-cereal food items such as eggs, milk, pulses, fruit and vegetables increases the relative price gap between the two categories. This discourages the production of non-cereal food items even if the demand for them is rising at a faster rate than that for cereals.

Further, the way food is stocked is also an issue. The main objective of Food Corporation of India (FCI) is to maintain buffer stocks; however, FCI buys whatever is offered. When it procures more than what is required as buffer, it creates a perceived shortage in the market and induces buyers to stock more than they need.

Procurement costs also contribute to food inflation. The economic cost of procurement includes MSP plus bonus, state taxes and the cost of storage and distribution. As a result, while the farmers sell, say, wheat at ₹14/kg, its economic cost to FCI is ₹24.70/kg. In case of rice it is Rs. ₹20 and ₹32.30, respectively.

Public expenditure on agriculture is 25 per cent of the agri GDP — which is quite high, yet farm productivity remains abysmally low for most crops. For example, per hectare yield for rice, wheat and onion are 2.4, 3.1 and 14.2 tonne compared to 4.7, 5.0 and 22 tonne respectively, in China. Besides, three-fourth of the public spending on farming is on inputs (power, fertilisers and water) subsidies and only a fourth is actually spent on improving agriinfrastructure.

That is not the best way to use public money. Studies show that per unit return on creating farm infrastructure or agriculture R&D is substantially higher than on input subsidies. Besides, deregulating prices of non-urea fertilisers while keeping urea price controlled has increased the relative price gap between urea and non-urea fertilisers, and promoted the unbalanced use of chemical fertilisers. This has led to soil degradation and lower return on each unit of fertiliser use.

Many believe that futures trading causes speculative investment and aid food inflation. The Government has banned or suspended futures trading in various commodities since 2003. Data show that non-traded agricultural commodities have witnessed greater price fluctuation than the traded ones. For example, vegetables prices rose 40.2 per cent in FY14 and accounted for one-tenth of the increase in the Wholesale Price Index — rice rose 16.5 per cent, moong 14 per cent and masur 12 per cent in FY14. None of these is traded.

Instead of banning commodity futures markets, policy makers should strengthen it. The small size of futures markets makes it easier for traders to manipulate them. Reducing margin requirements will encourage participation of small players in futures markets and keep a tab on unhealthy speculation.

Banning futures trade in essential food items, bringing onion or potatoes under ECA and raising minimum export prices (MEP) are desperate short-run measures, at best. India needs to abolish the APMC Act to link farmers directly to the retailers. There is a wide gap between wholesale and retail prices of fruit and vegetables mainly because of wastage. Allowing organised retail will improve post-harvest infrastructure, especially those related to storage of perishable items. This will check prices of fruit and vegetables.

Policy flip flops on export or import make farm markets unpredictable and hurt production planning. Imposing MEP is nothing but depriving farmers of better prices for their produce, which ultimately hurts production. A variable export tax system is a better way to deal with occasional domestic shortage of specific agricultural commodities. This will reduce price volatility and yet be less trade distorting.

High import duties — meat (100 per cent), rice (80 per cent), dairy products (60 per cent) or oilseeds (30 per cent) — can’t be justified when measures to tackle food inflation are proving to be ineffective. Besides, reduction of import duties will automatically keep ‘hoarding’ in check. The Government should spend on improving farm infrastructure and R&D. Bringing urea under ‘nutrient-based subsidy’ will help improve fertiliser mix and enhance productivity on a sustainable basis.

Sharma is an agricultural analyst. Kumar is a corporate economist. The views are personal